Taking A Fresh Look At Tesla Motors’ Value And Our Estimates

Tesla Motors (NASDAQ:TSLA) received a great deal of press coverage in the past few days. Shares of the Silicon Valley based automaker have jumped close to 100% in the last month and more than 50% last week after its earnings beat expectations. The automaker turned profitable for the time in the first quarter, which shows how far the company has progressed. In fact, the net income per share came in at 12 cents, which was ahead of the market expectations. [1]

We have raised our price estimate for Tesla to $69 following the impressive first quarter results. The growth in net income was driven largely by the improvement in gross margins at 17.1% during the quarter. This is in comparison to 8% registered during the 3-month period ending on December 31, 2012.

Margins rose largely because of improvements in the manufacturing process and supply chain optimization, which reduced the time required to build a car by 40%. In addition, Tesla was able to hit its peak production target of 400 units a week, something the company was unable to achieve until the fourth quarter of 2012. The company expects gross margins to improve to 25% by the end of the year.

However, we attribute a large part of our forecast revision in estimates to a significant jump in average revenue earned per model and better-than-expected improvements in operational efficiency.

Below are some of the factors responsible for the increase in our estimated price:

1) Jump In Average Revenue Per Vehicle

Since most of the sales are generally skewed towards lower priced versions of any particular model, one would have expected average revenues earned for every Model S sold to be in the region of $70,000-80,000. The starting price of a Model S in the U.S. is $69,900 before Federal tax rebates for buyers depending on the state in which they reside. But it turns out that the automaker recorded an average revenue per vehicle of close to $115,000. The reason why the figure is so high is because it includes revenues from the sale of ZEV (zero emission vehicle) credits to the tune of $60 million in the first quarter.

Not much information is revealed about their pricing or the number of credits sold, but reports suggest that Tesla receives as much as $35,000 for every Model S sold in California. The pricing varies from state to state so the average will come out to be much lower. Going forward it is also difficult to know to what extent Tesla can keep selling ZEV credits, and the company made a point to mention that its gross margin guidance of 25% for the end of year excludes these credits.

Keeping this is mind, we have increased the average revenue per vehicle for other yet-to-be-released cars such as the Model X and the Gen III. The Gen III is expected to be launched by 2015 at a starting price of $30,000 (i.e. the price paid by the customer after the tax rebates). Add to that the Federal tax rebates and the sale of ZEV credits, and the average revenue per vehicle should touch $40,000. Similarly, for the Model X, we have now upped the average revenue per vehicle to $95,000 taking into account the impact of ZEV credits.

Also, Tesla now expects 21,000 cars to be sold in 2013 – an increase of 1,000 cars from the previous estimate. Although the percentage isn’t very significant, the move highlights that Tesla’s production has finally hit full throttle, and it looks less likely to encounter any major production hiccups. It also reaffirms that demand for the vehicle is likely to remain strong throughout the year despite its high price tag and niche target market of prospective buyers. Moreover, the glowing reviews received for the Model S lately (Consumer Reports gave the Model S a score of 99 out of 100) bode well for for its yet-to-be-released models.

2) Improvements in Operational Efficiency

Fast growing companies often witness huge improvements in operational expenses when expressed as a percentage of revenues or profits.

In 2012, the adjusted selling, general & administrative (SG&A) totaled $129 million, which translated to more than 400% of its gross profits. We had earlier expected the corresponding figure in 2013 to total $300-$320 million, or about 65-70% of expected gross profits. [2] This would still have been a huge improvement. However, Tesla’s first quarter results exceeded our estimates, and we now expect SG&A expenses to equal $190-$200 million (~32-33% of gross profits). The huge improvement has been mainly due to gross profits growth outpacing that of administrative expenses like office, information technology and facilities-related costs to support the growth of their business.

Besides improving the cash flow for 2013, this also reduces our expectations for SG&A expense in the subsequent years, which accounts for a substantial portion of the change in our estimates.

However, these assumptions do involve greater risks now. There is always a possibility of the average sale price of a ZEV credit going down due to greater participation from other automakers or a future change in the state laws. A decrease in ZEV credit pricing will adversely affect margins as well, which could consequently impact the future performance of operational metrics. To account for the greater risks, we have increased our discount rate from 12% to 14%.

We caution that while investors have lapped up Tesla’s shares with optimism about its ability to maintain its rapid growth as evidenced by how well received its announcement that it would raise around $360 million in a secondary equity offering and around $660 million in convertible bonds, a lot of uncertainty remains about its future given how new the company is. Given how much of its results were driven by tax incentives and carbon credits, the coming quarters will provide very important data on the outlook for these factors.

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